The Shocking Truth About Yield Curves
You can’t turn on the news without hearing about interest rates. Yet, despite all the attention interest rates garner, many miss a remarkable pattern and life lesson.
Before we delve into remarkable patterns and causal correlation, let’s clear the air regarding interest rates. Interest rates determine the cost to borrow, either short term or long term. They also determine the yield investors can get in return for locking up their liquid assets for a predetermined time period.
How often have you either heard or read, “Interest rates are falling,” or, “The Fed is raising interest rates” or some such news regarding interest rates (rates, plural)?
Folks tend to mix up the rates monopoly-controlled by a country’s central bank—in America, the Federal Reserve, aka the “Fed”—and market-set rates.
If America’s Fed feels it should reduce or increase money supply, one tactic is to raise or lower, respectively, the federal funds target rate. The Federal Open Market Committee (FOMC) meets eight times yearly to discuss if it should raise, lower or stay the fed funds rate (also sometimes referred to as the overnight rate or the short rate) and how much the rate should move, if at all.
The short rate is that at which banks lend to each other and drives the interest rate banks pay you for deposits (savings accounts and certificates of deposit [CDs]). This is the rate (singular) investors mean to imply when they talk about the Fed monkeying around with rates. ...